While it is possible to start some business, especially the online variety, with minimal capital, other small business startups will require some capital to get started. The Small Business Success Blog claims that the average startup cost for a small business in the U.S. is $68,000 which is not insignificant. Pulling together that type of money can be a daunting and seemingly insurmountable task, especially for younger entrepreneurs just starting out and for those with a poor credit score or history.
As a beginning entrepreneur with no credit history and no collateral your options are limited. Banks and credit unions, the traditional sources of finance for small businesses, have been keeping their pockets closed since the beginning of the Great Recession. Even so, you would need a stellar credit score and a minimum of 20% of your own capital to even hope to be eligible for a bank loan. And many banks require detailed financial statements, which you certainly won’t have as a new startup.
One popular form of startup capital for new entrepreneurs is friends and family. Securing a loan from these people is often much easier than bank financing as they already know and trust you. They will most certainly be able to get you funding more quickly than a bank, and you won’t be required to submit reams of paperwork in the process. On a negative note, should you fail to repay the loan in a timely fashion (or at all), you risk the endangerment of long lasting relationships.
Working outside the traditional bank lending framework need not be complicated or difficult. Here are 6 tips for new small businesses looking at alternative methods for financing a startup:
- Be careful about who you approach for financing. You need to think like a business person when deciding whom you will ask for startup financing. Sure it might be easy to turn to your brother, your dad, or your best friend, but you should consider if they are the best choice. You should really look for someone who has knowledge and skill when it comes to business to ensure that they are fully aware of what they might be getting themselves into. Someone who can evaluate the risks and rewards of investing in you and your business and will understand the possible repercussions if your business fails to take off. At the very least it should be someone who has complete faith in you, understands what you are trying to achieve and the time frame involved in your success.
- Show your potential lender that you are both passionate and detailed about your new business. Having a great idea is one thing, but showing that you know how to turn that idea into a reality through detailed research and a business plan is quite another. Before you ask for money make sure you have done your due diligence and can present the reasons for and against your business idea. Creating a business plan is an excellent idea, even if it is just a short mini-plan. This will show that you know about your market and can determine potential profitability for your business. Most importantly, it will let your potential lender know how his or her money is going to be spent. These business plan guides from Entrepreneur.com are a great place to get started on your plan.
- Don’t ask for more money than you really need. Sure it might be nice to have $100,000 for your startup, but if you only really need $30,000 to get started then that’s what you should ask for. Rather than going all out, determine how much you would need to get through the first few months of business and use that as a starting point. Once you show that your business is viable and you are able to repay you will be in a good position to ask for more money if necessary. Also be sure to communicate with your lender and let them know how your business is progressing. It will give them peace of mind knowing about your successes and even your failures if you can show what you’ve done to avoid similar failures in the future.
- Decide before asking if you would consider offering a share in the business or if you simply want a loan. This requires some very careful and deliberate thought. With a loan you will have to repay the money, while a share in the business means a direct investment that won’t need to be repaid, but it will mean that you surrender some leverage in how the business is run. Giving up a share of the business might be helpful if your partner has business knowledge that is relevant and can mentor you to help the business succeed. But do you really want a family member or close friend involved in the daily operations of your business? This can be a time bomb just waiting to explode.
- Consider using a peer to peer lender or other alternative source such as crowdsourcing. P2P companies act as intermediaries in the loan process, matching borrowers with lenders. They have become very popular over the past several years as a source of quick capital for small businesses. The downside is the high interest rates that you might face. A similar situation is a crowdsourcing site. These sites allow you to ask for what amount to donations to fund your business. They are very popular in the artistic community, but have also been used as startup capital for restaurants, agricultural concerns and other businesses considered to be closely tied to the community.
- Before asking for a loan make sure you’ve already drafted a repayment agreement. Even in a case where you are borrowing money from a close family member or friend, it is still a business transaction and needs to be handled as such. The agreement should include your business plan, how the funds will be used, repayment terms and prepayment terms. If you are getting into an investment situation where the financer will be taking a stake in the company it is equally important to outline the agreement beforehand to protect your family and friends, yourself and your business.
Starting a business of your own is an excellent way to break away from the clutches of corporate America, but it is also a great responsibility. Treat it as a business rather than a hobby (even if it stems from a hobby), and you will be more likely to have success.